Armenia’s Economy since Independence

The article was first published at the London-based Foreign Policy Centre.

Foreword

A common analysis of Armenia’s economic performance since independence typically focuses on the limitations imposed by geography and geopolitics and mostly ignores, or at best glosses over, the failures of governance and policy to deliver on what could have reasonably been expected. Proponents of such views fail to provide conclusive evidence of trade-imposed barriers to growth and progress in Armenia, or explain why other countries with similar governance characteristics but unhindered external trade remain poor. While I recognize the limitations imposed by the geopolitics and security considerations on the economic and social outcomes in general and in the Armenian context in particular, I am of the view that policymakers in Yerevan since 1991 have imposed additional constraints that became significantly more binding than geography and security and adversely influenced economic and social outcomes. The remainder of this article builds on this premise and highlights the specific policy failures that, in my view, are to be blamed for the current state of economic and social affairs in Armenia.

Armenia’s Economic Performance

Armenia’s path since independence from the Soviet Union in 1991 can be broken down into three rather distinct periods as follows: (i) 1991-99 (ii) 2000-07, and (iii) 2008 to present day. I highlight the specific features of these periods in Armenia’s independent history in detail below.

Post-Transition Progress (1991-99)

Armenia’s return to growth in 1994—the first among the former Soviet republics still recovering after the collapse of the USSR—was nothing short of remarkable and was achieved while the economy was recovering from the impact of a devastating earthquake and a full-blown war with the neighboring Azerbaijan.

Growth was underpinned by speedy and largely successful small- and medium-size state-owned enterprise and land privatizations. Yet the failure to create conditions for proper functioning of the markets and the lack of a meaningful role for the state became key constraints for progress thereafter. Ongoing conflict in Nagorno Karabakh and the legacy of a highly industrialized but by now mostly obsolete economic structure did not help.

Here is a short list of factors that proved critical and have influenced much of what had happened next:

First signs of the nouveau richeconcentrating sizable wealth and getting close to economic decision-making have emerged.

The seeds of authoritarian governance were effectively sown. Generals, returning from the front lines, were getting increasingly powerful and had a major role to play in the hotly contested and violent 1996 election.[2]

The promise to get the Diaspora involved meaningfully in rebuilding Armenia was effectively reversed.[3]

The assassination of then Prime Minister Vazgen Sargsyan—a controversial figure, who nevertheless is widely seen as perhaps the only hope Armenia had for building a strong statehood—and six others on October 27, 1999 in the parliament ended this period. The very high levels of public buy-in and social cohesion, which were present during the early 1990s but almost disappeared during the post-war reconstruction period, surfaced during V. Sargsyan’s short tenure in office, to never re-appear again.

Qualitative Stagnation (2000-2007)

The period coincides with the rule of Robert Kocharyan, whose particular political skills allowed him to consolidate power after the October 1999 assassinations and played a dominant role in this handling of both political and economic affairs in the country. This period witnessed double digit growth of GDP and macro-financial stability, but was marred by much of the same lack of regard for good governance and properly functioning markets.

The construction sector, which was the main engine of growth during this period, absorbed sizable amounts of credit and labor resources, driving interest rates, exchange rate, and wages up throughout the rest of the economy. Under these conditions and without effective policy intervention, the economy failed to diversify despite very strong signs of promise shown by some sectors (most notably, IT and agro-processing), effectively preparing the ground for the dramatic decline of GDP in 2009 (see below). Remittances and other transfers from abroad, which fueled this construction boom, complicated the macroeconomic management and created adverse dependence at the microeconomic/household level.

On the budgetary side, the period is characterized by a highly pro-cyclical fiscal policy, with budget being in deficit even during years of double digit growth. Despite this, Armenia’s spending on health, education, and public investment was among the lowest in the world measured as percent of GDP. Much of this was underpinned by poor tax revenue collection, itself a function of the presence of powerful oligarchs that were outside of the reach of the tax authorities. These oligarchs have functioned under the direct patronage of country’s political leadership and grew more influential in public life and economic decision making. The resulting monopolies in production and import of key commodities curtailed competition, limited growth, and resulted in higher prices.

“In the doldrums” (2008-present)

This period is characterized by political upheaval of 2008 and the impact of the global crisis. The poor crisis preparedness and inadequate policy mix during 2008-09 (with disproportionate reliance on externally financed fiscal stimulus compared to exchange rate and structural policies) resulted in a 14.2 percent decline in GDP in 2009, one of the worst performances in the world since the beginning of the current crisis.[4] After 4 years, real GDP is still below its 2007 level and is projected to grow only modestly in the medium term, with sizable headwinds from Europe likely to undermine this outlook.

While some attempts were made to raise the level of tax-to-GDP, these efforts faced resistance from the oligarchs and the decline in economic activity. This put most of the burden of the stimulus on foreign borrowing. Public debt, while still largely on concessional terms, has reached alarming levels and composition (in excess of 40 percent of GDP by end-2011 from 16 percent as of end-2008, with close to 90 percent of it denominated in foreign currencies), with a sizable chunk of repayments scheduled for 2012-14.

Here are some highlights that should help get a better sense of the governance and policy landscape in the country at present:

State capture, the control of the economy by special interest groups, has gotten worse. Economy remains highly concentrated in the hands of people directly/indirectly involved in politics.

Migration, by now of the middle class, has intensified; [5] inequality and poverty are rising.

Developmental agenda is lacking and any future plans to vitalize the economy will face an overvalued exchange rate, corruption, uneven playing field, and weak property rights.

Overall, it is unclear as to where the potential growth could be coming from going forward, assuming the same quality of governance, ongoing political polarization and social discontent following the March 1-2, 2008 killing of demonstrators, and continued disengagement of the Diaspora (that may have acted as a catalyst for foreign investment and a champion for better governance). In the meantime, much of the same policies are being pursued and population is growing frustrated by the day with the regime’s handling of economic and social affairs and the brave face it puts while explaining its failure to deliver on promises.

In conclusion

Despite the mounting challenges on almost every important front, there remain grounds for optimism. Clearly, the experience of early 1990s, with progress made under the most severe of conditions, as well as the still sizable human capital and strong commitment to “making it work” among local population and the Diaspora, provide hope for the economy’s future, given better governance. Also, experience of neighboring Georgia, with swift improvement in governance and the elimination of retail corruption, is very encouraging. All in all, with a clean and democratic political leadership that can unite all constructive forces and help attract investments and talent from the Diaspora; a technocratic government that understands how the modern world functions and offers a meaningful way forward; and a strong public buy-in to underpin the reform efforts, there is practically no limit to what the country can achieve despite the constraints that are imposed by geography and security.

But we are not there yet and time is running out quickly given the scale and the scope of challenges posed by the pervasive nature of whole-sale corruption, adverse demographic developments, and challenging geopolitics. The main directions of the effort should be aimed at de-politicizing economic decision-making and building a vision as well as development-intensive policy capacity. The alternative to following this path is worrisome, if not outright scary.

David Grigorian is a Senior Economist at the International Monetary Fund's Monetary and Capital Markets Department and a co-founder of Policy Forum Armenia, a virtual think tank with world-wide membership. He holds a Ph.D. in Economics from the University of Maryland at College Park and has published on a wide range of issues including growth and institutions, prices and fiscal policy, remittances, capital markets, and banking.

Policy Forum Armenia (2008b). “Implications of the World Financial Crisis for Armenia’s Economy,” PFA Special Report. Available from: www.pf-armenia.org/reports.

Policy Forum Armenia (2010). “ Armenia-Diaspora relations: 20 Years Since Independence,” a State of the Nation Report. Available from: www.pf-armenia.org/reports.

[1] Based on remarks delivered at the conference on "The South Caucasus: 20 Years On", organized by the Carnegie Endowment for International Peace on November 28-29, 2011, in Washington, D.C. The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

[2] While no demonstrators were killed, Amnesty International (1996) describes the use of force and repressions against civilians in the aftermath of the election, where the incumbent received 51.75 percent of the vote, barely sufficient to avoid the second round. PFA (2008a) puts those developments in the context of the prevailing political culture of the time.

[4] For a discussion of alternative policies available to the government in the sake of the crisis, see PFA (2008b).

[5] While still largely anecdotal, some evidence of this began surfacing following the release of the US diplomatic cables from the Embassy in Yerevan describing the phenomenon and providing specific examples.

It is so sad that Armenians worldwide are rejoicing over the petless French decision instead of concerning ourselves with what really matters. The points Dr. Grigorian has brought up in this article.

2. Aram07:59 - 25 January, 2012

An interesting, objective sounding and a succinct presentation of Armenia's economic upward and mostly downward policies the last twenty years.If not an A it is definitely a B plus

3. rahageets09:22 - 25 January, 2012

The author mentions "there is ground for optimism" regarding Armenia's economic future, but then states the country is far from achieving those conditions that would permit such optimism to actually be realized in the economic sector. Does anyone one actually believe that Armenia is on the correct track to "good governance", depoliticization of politics/economy and a "technocratic leadership" that actually possesses a vision for the future of Armenia? The article provided little in the way of analysis as to what steps need to be taken in this regard. Furthermore, it would appear that the author is a proponent of free-market capitalism and the political "democracy" that goes with it. Armenia needs to search for other models in my humble estimation.

4. LG11:03 - 25 January, 2012

David said a whole lot without actually saying anything of substance. And it should be disclosed that David was part of the Ter-Petrosyan administration. It is well known that during this time, many of the socio-political ills Armenia is dealing with today were introduced and entrenched. Moreover, the IMF, which David now works for, has praised the handling of the financial crisis by the Armenian government; so too has the World Bank.

5. David Grigorian20:21 - 25 January, 2012

Mark/Aram,
Thank you for your comments. I will take the B+ as long as you are receptive to what I am saying. :-)
Rahageets,
I am afraid you missed the whole point of the article. In fact, I am saying that only when/if Armenia secures those preconditions it would have hope for going forward and developing. This is another way of saying that Armenia still does not have those preconditions in place....but it has other thing—the will of its people to succeed—that could change the situation overnight. In terms of how much substance the article has by way of offering a way forward, my remarks at Carnegie (which is what this particular article is based on) were meant to be an overview of the 20 years of experience, and not a forward-looking piece. For more specifics as to what can be done going forward, please stay tuned to the Policy Forum Armenia’s upcoming report on the economic crisis in Armenia, which we hope to issue within the next 2 weeks: there will be plenty of specifics in that report! Regarding my views on the economic model that Armenia should/could pursue (re: your capitalism remark), they are best expressed in my 2003 join paper with Richard Beilock, where we describe the role of the government in economic development of Armenia through the public-private partnerships (PPPs). If you cannot find that paper on-line (it is available), I will be happy to send it to you. Regarding “political democracy”, indeed I see no alternatives to the right of people of Armenia to choose its own leaders through a fair and free election.
LG,
I was a student during Ter-Petrosyan administration; left Armenia right after the end of the war in June 1994 (for my graduate work in Europe); and with the exception of my 2-month long internship with the Central Bank (while I was a student at the AUA) I had not worked—not for even a day—in any official institution/organization (much less the government of Armenia). Regarding my political views, I have been in opposition to LTP since the 1995 election and I am now. So this should take care of your allegations.
Regarding my IMF affiliation, please note that IMF economists are allowed to have views that differ from that of the institution, which is what this article describes. Regarding my views on Armenia’s handling of crisis, I should tell you that I am the principle author of Policy Forum Armenia’s report on the crisis (titled “Implications of the World Financial Crisis on Armenia’s Economy”, published in December 2008 and available from http://www.pf-armenia.org/reports/) and my views are expressed there. This is the single most daring criticism of the policy choices that were employed back then and contained the most detailed set of recommendations on how to mitigate the impact.

6. rahageets07:11 - 26 January, 2012

@ David - "The will of the people to succeed..." Is this a line taken by one of the Republican Party presidential wannabees in the States? Rather than miss the point, this leap of faith from A to B, is the KEY POINT. If we had this or that Armenia would usher in a new age of economic prosperity? I understand that the piece is a retrospective on what has lead Armenia to its current sorry state of economic stagnation, political disenfranchisement and lack of national will to set clear goals for the future, but what is needed today are creative strategems to bridging the gap. Can the World Bank/IMF overlords of national economies provide such solutions? Many in post-Soviet nations would laugh at the suggestion. Can the West/Europe guarantee free and fair elections in Armenia or a modicum of "good governance"? Of course not.Hopefully,upcoming Policy Forum paper you speak of will adress these points as well.

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